India Move to Douse Gold Demand Unlikely to Succeed

By

Biman Mukherji

Updated June 6, 2013 7:18 a.m. ET

NEW DELHI—India's decision to raise the import tax on gold for the third time in 18 months is unlikely to help the government narrow a widening trade deficit and may only drive trade to illegal channels, traders and analysts said Thursday.

The government late Wednesday increased the import tax on refined gold to 8% from 6% and on gold ore and intermediate products to 7% from 5%. The tax hikes are meant to reduce demand for imported gold, which has worsened India's trade deficit and pushed the rupee this month to the verge of all-time lows against the U.S. dollar.

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The latest tax increase followed a surge in demand since mid-April, as the international price of gold fell to a two-year low. Global investors have moved out of gold amid diminished worries about inflation and rising global stock markets. Gold is typically seen as a hedge against inflation.

But in India the price decline spurred demand from consumers ahead of the peak wedding season and the festival of Akshaya Trithiya, considered one of the most auspicious occasions for buying gold.

Finance Minister
P. Chidambaram
told a banking conference in Mumbai that the government had no other option but to take "strong measures."

"How is this sustainable? How can we finance the gold imports?" he said.

India is the world's largest net importer of physical gold, which is popular for wedding gifts and as a store of savings for rural dwellers who have no access to banks and fear inflation will wipe out savings held in paper currency.

Amid weak prices, an increase of the import tax by two percentage points is unlikely to have much of a dousing effect on demand, said Gnanasekhar Thiagarajan, director of Commtrendz Risk Management, an India-based consultancy.

"It will have a very limited impact," he said. The move "won't deter buying on festival occasions or when prices fall."

Mohit Kamboj,
president of the Bombay Bullion Association, said the tax increase could spur more gold smuggling as importers try to avoid the new levies, which would reduce government revenues.

Gold will be 10% more expensive in India than in the international market after the latest tax increase, said
Pankaj Parekh,
vice chairman of the Gem and Jewelry Export Promotion Council.

An Indian finance ministry official acknowledged that there was a possibility of a rise in smuggling: "We are aware of this and trying to plug the loopholes."

The government had increased the import tax to 6% from 2% over the past year and a half to make local purchases costlier. But these moves have been blunted by the decline in the global price of gold.

In the past, Indian consumers haven't been deterred from buying even as prices rose sharply, because of gold's important role in religious ceremonies and marriages and as a store of wealth,
Mr. Thiagarajan
said. "Prices of Indian spot gold have risen by almost 500% in the last one decade," he said, while demand also has increased. The import tax would have to rise to 20% to have an effect, he added.

He said the government had likely erred in its timing of the import-tax increase because gold demand usually slows between July and September, during which farmers look to invest surplus cash to buy seed during the monsoon sowing period, meaning there is less money available for gold purchases. About 70% of India's gold demand comes from rural areas.

Gold buying is expected to pick up from October, after the harvest, particularly as India's monsoon rains are forecast to be abundant this year, which should boost crop yields and farmers' incomes.

Industry officials said the tax hike would only make it costlier to import gold, affecting thousands of small cash-strapped jewelers.

"Our members will meet either today or tomorrow and then will decide on the plan of action," said
Haresh Soni,
chairman of the All India Gems & Jewellery Trade Federation.

Jewelers went on a 20-day nationwide strike in March last year after the government doubled the import tax to 4% and imposed a factory-gate tax on gold jewelry. They resumed business only after the government scrapped the factory-gate tax, a tax charged in a finished product.

Mr Soni said that the government should not try to cut down all gold imports because the bulk of the precious metal is used for making jewelry, which employs millions of poor artisans.

Instead, the government could block sales of gold coins that are bought by speculative investors and account for about a third of the precious metal's consumption, he said.

Finance Minister Chidambaram said he had directed banks not to encourage the sale of gold coins.

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